On December 13, 2017, a New Jersey federal judge dismissed the US Securities and Exchange Commission’s (SEC) civil action against the owner of a broker-dealer for his alleged involvement in a $17 million pump-and-dump penny stock scheme, holding that the five-year statute of limitations for punitive remedies barred the lawsuit.
In SEC v. Gentile, No. 16-1619, the court held that the relief sought by the SEC—an “obey-the-law” injunction and bar from trading penny stocks—was punitive in nature and thus subject to the five-year statute of limitations for civil penalties set forth in 28 U.S.C. § 2462. The court stated: “[A] remedy, including an injunction, is penal in nature when it serves no retributive or remedial purpose and merely seeks to punish an individual.”1
The defendant, along with co-conspirators, was alleged to have used misleading promotional materials to manipulate the stock price of Raven Gold Corp. and Kentucky USA Energy Inc. The alleged scheme ended in 2008, meaning that the SEC would have had to file its case by 2013, if the five-year statute of limitations applied. The SEC filed its case in 2016.
In finding that the injunctive action was barred by the five-year statute of limitations, the court relied on the Supreme Court’s analysis in Kokesh v. SEC, finding SEC actions for disgorgement subject to the same five-year statute of limitations.2 Citing Kokesh, the court noted that “[w]hen an individual is made to pay a noncompensatory sanction to the Government as a consequence of a legal violation, the payment operates as a penalty.”3
The crux of the decision was whether the relief sought by the SEC was punitive in nature, thus subject to the statute of limitations. The court determined that the “obey-the-law” injunction—simply requiring the defendant to abide by federal securities laws—would stigmatize him and not compensate any victims. Likewise, the penny stock bar “would only serve to punish” the defendant.4 The court found that the defendant would be “the only person who would be impacted by such . . . order[s],” which “would not restore any ‘status quo ante’ nor . . . serve any retributive purposes. Rather, [they] would merely restrict defendant’s business structure and methodology, in perpetuity, simply because he was alleged to have violated securities laws when he purportedly was involved in the . . . schemes.”5
Gentile appears to be a logical extension of Kokesh. The court recognized that injunctions—particularly for old conduct—are inherently punitive. Obey-the-law injunctions are more than a mild prophylactic. In reality, the consequences of injunctive relief often go well beyond the terms of the injunction itself. The collateral consequences of an injunction can be severe, as the Gentile court recognized, from personal and professional stigmatization to the loss of one’s livelihood.
But not all courts agree with Gentile’s reasoning. Earlier this year, the US Court of Appeals for the Eighth Circuit analyzed whether Kokesh bars the SEC from bringing injunctive actions more than five years after the misconduct occurred.6 In that case, the court found it unnecessary to determine whether an injunction is a penalty under section 2462, because (1) the defendant continued operating his business after the action was brought and thus there was a reasonable likelihood of future violations; (2) the injunction was meant to protect the public prospectively from the defendant’s wrongful conduct rather than punish him; and (3) the injunction only required the defendant to obey the law.
The Gentile court, however, easily dismissed the Eighth Circuit’s concerns thusly: “Simply alleging that Defendant violated securities laws does not lead the Court to conclude that Plaintiff is likely to violate securities laws in the future. The fact that Defendant boasted about ‘not scamming anyone’ during an interview and made shrewd comments about the [SEC] on social media also does not indicate that Defendant will violate federal securities laws in the future.”7
The Gentile decision likely will not impact courts’ general analyses about whether to order injunctive relief for ongoing or recent misconduct. Moreover, it is too early to predict whether its reasoning signals the death knell for SEC injunctions for conduct more than five years old, given the conflicting decisions. In any event, defendants and the SEC are now on notice that courts may be receptive to a further limitation on the SEC’s remedies in civil actions.